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ONGC: Black gold does glitter

Feb 1, 2005

Performance summary
Oil and Natural Gas Corporation, the country's largest oil and gas exploration and production (E&P) company with over 80% of the volumes share announced its 3QFY05 and 9mFY05 results late yesterday. The company has witnessed an impressive growth of nearly 68% YoY in the topline while the bottomline has improved by over 103%. However, if one takes into account the fact that the company accounted for the 9mFY04 subsidy share in its 3QFY04, the bottomline growth dips to around 63% YoY, still an impressive growth.

What is the company's business?
ONGC is the country's largest E&P company accounting for nearly 90% of India's proven oil and gas reserves. At the current rate of production, the company accounts for over 80% of oil and gas production. Apart from E&P, the company also produces value-added petroleum products such as LPG, kerosene, naphtha and diesel. While LPG is sold to the PSU marketing companies, a major chunk of naphtha is exported and diesel is used for captive consumption. ONGC also has a 72% stake in MRPL, a stand-alone refinery with capacity of nearly 9.7 MMT (million metric tonnes). Together with MRPL, ONGC has planned its downstream fuel-retailing venture and has a license to set up nearly 1,600 retail outlets.

(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change
Net sales 72,277 121,035 67.5% 237,563 342,140 44.0%
Expenditure 34,570 58,172 68.3% 103,440 164,162 58.7%
Operating profit (EBDITA) 37,707 62,864 66.7% 134,123 177,978 32.7%
EBDITA margin (%) 52.2% 51.9%   56.5% 52.0%  
Other income 3,480 4,616 32.6% 10,880 12,367 13.7%
Interest 33 170 416.4% 175 275 57.0%
Depreciation 13,392 12,863 -4.0% 39,025 44,432 13.9%
Profit before tax 27,762 54,446 96.1% 105,802 145,639 37.7%
Tax 10,577 19,513 84.5% 39,022 53,785 37.8%
Profit after tax/(loss) 17,185 34,933 103.3% 66,781 91,854 37.5%
Net profit margin (%) 23.8% 28.9%   28.1% 26.8%  
No. of shares (m) 1,425.9 1,425.9   1,425.9 1,425.9  
Diluted earnings per share (Rs)* 48.2 98.0   62.4 85.9  
Price to earnings ratio (x)         9.6  
(* annualised)            

What has driven performance in 9mFY05?
Robust crude prices drive topline:  For the nine-month period, ONGC has witnessed a robust topline growth of nearly 44% YoY on the back of strong crude oil prices. To put things in perspective, the company's average realizations have increased by nearly 38% during the period, as compared to the average price of US$ 29 per barrel in FY04. Also, during this period, volumes increased by nearly 3% YoY. But for the rising subsidies on natural gas on account of higher price differential in international markets and domestic regulated prices, the company could have witnessed a huge jump in revenues.

Expenditure Table
(%) of sales 3QFY04 3QFY05 9mFY04 9mFY05
Consumption of raw materials 0.8% 0.3% 0.6% 0.2%
Purchases 0.0% 11.8% 0.0% 11.5%
Staff cost 2.1% 1.8% 2.7% 2.4%
Statutory expenditure 28.9% 21.4% 26.5% 21.8%
Other expenditure 16.1% 12.9% 13.7% 12.1%

Trading proves costly:  ONGC has witnessed a 450 basis points dip in its operating margins during 9mFY05. However, we believe that on a YoY basis, this is not comparable given that in the current fiscal, ONGC has started trading MRPL's products on its own books, which was hitherto absent in the last fiscal. Better global scenario has helped the company's revenues grow at a faster rate as compared to expenditure, thereby arresting any further decline in operating margins.

Reading between the lines:  On the face of it, the company has witnessed an impressive growth of over 103% in the bottomline in 3QFY05. However, during the corresponding period last fiscal, the company accounted for the entire 9mFY04 subsidies in 3QFY04, thereby understating revenues and bottomline by some extent. If the previous two quarters are excluded, the bottomline growth in 3QFY05 is 63% YoY, which is still impressive. This growth is boosted to some extent by the other income growth of nearly 33% YoY.

What to expect?
At Rs 821, the stock is trading at a price to earnings multiple of 9.6 times annualized 9mFY05 earnings (price to cash flow multiple of 8.6 times). We believe that the current uptrend in crude oil prices is likely to continue over the medium term and this is likely to aid ONGC's revenue growth, as crude oil constitutes nearly 69% of the company's revenues. ONGC is now eyeing a 15% stake in Yukos' asset in Russia through its subsidiary.

The fact that the government is contemplating a price hike in case of natural gas augurs well for the oil and gas major. To know more about the impact of gas price hike, click here.

We had recommended a BUY on the stock at Rs 840, with a medium term target price of Rs 1,235. The stock has now fallen below the recommended price. However, we continue to maintain our view on the stock.

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